Instruments traded in the stock markets Part II - Stock Market FAQs

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Instruments traded in the stock markets Part II 

• What are Company Earnings?

Earnings are a company's net profit. It is the surplus left with the company after it has cleared all its expenses, i.e. Money paid to employees, utility bills, costs of production and other operating expenses. The manner in which a company makes its earnings, is defined by the very nature of its business.

For eg.

A Steel manufacturer produces steel for sale to its customers.
Two sources of company earnings are:

• Income from sales of goods or services
• Income from investment.

Investments generate income for businesses by way of either interest on loans, dividends from other businesses, or gains on the sale of investment property.
Thus, company earnings are the sum of income from sales or investment left after the company has met its obligations. 

• Why are Earnings important to an investor?

As an investor who holds shares of the company, you have part ownership of company.When you invest in a company's shares, you become a 'part owner' of the company and you get to share a part of the company's profit as dividend. Thus , if the company does well and earns more profit, you in turn to well. If the company reinvents its earnings towards future growth, you are assured of higher dividends in the future.

Meanwhile, if you lend money to the company by investing in its bonds, the company uses part of its earnings to repay interest and principle on the bonds. The more earnings the company has, the more secure you can be that the company will be able to make your interest payments. So, company earnings are important to you because you make money when the business you invest in, makes money. 

• How to use earnings information to make an investment decision?

Your investment goals determine how you use information about company earnings. If you are an income investor, interested in earning immediate income from your investments, you probably want to invest in a company that is paying dividends. If you have a long-term investment strategy, dividends may not be as important to you. The "financials" indicate whether a company is oriented for income, growth, or a bit of both. By comparing the financials for different companies in the same industry, you can find characteristics best suited to your investment goals.

A convenient way to compare companies is through Earnings per share (EPS). EPS represents the net profit divided by the number of outstanding shares of stock.

When you compare the EPS of different companies, be sure to consider the following:

• Companies with higher earnings are stronger than companies with lower earnings.
• Companies that reinvest their earnings , may pay low or no dividends but may be poised for growth.
• Companies with lower earnings, and higher research and development costs, may be on the brink of either a breakthrough or a disaster, making them a risky proposition.
• Companies with higher earnings, lower costs and lower shareholder equity, might go in for a merger. 

• How do I use Fundamentals to make an investment decision?

Fundamental Analysis is a method used to evaluate the worth of a security by studying the financial data of the issuer. But this research can never accurately predict how the company will perform in the stock market. It can however be used as a good comparative framework to know which company will be a better investment choice.

As an investor, you are interested in a corporation's earnings because earnings assure higher dividends and potential for further growth. You can use profitability ratios to compare earnings for prospective investments. These are measures of performance showing how much the firm is earning compared to its sales, assets or equity.

You can quickly see the difference in profitability between two companies by comparing the profitability ratios of each.

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